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Accounting for Inventory- Journal entriesCosting SystemsGSTWeek 71LEARNING OBJECTIVESDescribe the nature of inventory and retail operationsDescribe the basic format of an income statement for retail businessesAccount for sales transactions of retail businesses, including GST, the treatment of sales returns, cash discounts, trade discounts and freight costsAccount for purchases of inventory and cost of sales under both the perpetual and periodic inventory systemsDescribe the net method of recording purchases and sales whenever there are settlement discountsINVENTORYAASB 102/IAS2 - InventoriesInventory means goods or property purchased and held for sale in the operating cycle of a businessOther assets may be sold from time to time but do not constitute inventoryAlso know as stock or stock in tradeDifferent types of business operationsService firms:provide services to customers eg lawyers, accountants, hairdressers, schoolsManufacturing firms:purchase raw materials and convert them to finished products, which they then sell eg bakeries, car manufacturers, Levi Strauss Merchandising firms:purchase and resell finished products for profit eg department stores, newsagents, Just Jeans

RETAIL BUSINESS OPERATIONSDetermination of profit is a major objectiveCalculation of cost of sales is keyThis is often a retailers largest expenseThe inventory asset is often a significant part of total assets and is likely to be very activeRETAILING AND THE GSTRetail business must register for an Australian Business Number (ABN) if their sales of goods exceed $75 000They must also register for GSTThey must issue tax invoices and collect GSTThey can claim input credits (GST outlays)As a result, record keeping is very important

SUNRISE CD SALESIncome Statementfor the year ended 31 December 2012

Merchandising (Retailing) BusinessOperating revenues Sales revenue $714 900 Less: Sales returns (22 010) Net sales revenue $692 890Less: Cost of goods sold470 490GROSS PROFIT222 400

Add: Other Operating Revenues Interest revenue 100 Less: Other Operating Expenses Selling expenses$100 270 Administrative expenses78 850 Financial expenses4 260 (183 380)NET PROFIT (before tax)$ 44 380 ACME AUTO REPAIRSIncome Statementfor the year ended 30 June 2012

Compare to the Service BusinessRevenues Repair revenue $147 500

Expenses Advertising expense$ 6 750 Repair supplies expense30 570 Salaries and wages expense42 600 Rent expense13 420 Telephone expense6 730 Light and Power expense15 980116 050NET PROFIT$ 31 450 DISCOUNTSCash DiscountsSome firms extend cash discounts to their credit customers to encourage prompt payment of their accounts.indicated on sales invoice eg. 2/10, n/30 or 0.5/5, n/14, or net 30 etc.usually deducted by the purchaser when making paymentTrade DiscountsNot to be confused with cash discountsMostly seen as a percentage reduction granted to customer from the list price (usually at point of sale and shown as Sale 20% off today!)The buyer or seller only records the actual price paid for the goods (does not record discounted effect)

FREIGHT COSTSFreight inward costspaid by the firm when purchasing inventoryFreight-in Expense is part of cost of purchasing inventory (added to the asset)

Freight outward expenseWho pays freight costs? The buyer or the seller? FOB shipping point or (EXW) buyer takes delivery from sellers place of business buyer pays all transport costsFOB destination or (DDP) the seller delivers to buyers place of business seller pays all transport costsClassified as a selling expense if the seller is responsible

INVENTORY SYSTEMSEach merchandising firm must decide how they are going to account for their inventoryThere are two systems available. These are the: Perpetual inventory systemContinuous record of all movements in inventory levelsPeriodic inventory systemRecords of inventory numbers are not kept continuously but are calculated periodically using stock takesThe method chosen typically depends on factors such as the type of inventory, the size of the company, the technology and resources available.SUMMARY - PERPETUALInvolves keeping a running record of each purchase and saleThe inventory account and COS account is updated after every purchase or sale As a result, the balance in the inventory account is the ENDING inventory amount.A stocktake is only performed to verify the accuracy of this recorded ending inventoryIf the recorded inventory and the stocktake differ, then an entry to record the correct amount needs to be processedImplications of Choice of Inventory systemImportant!The choice of inventory system used (perpetual or periodic) will mean:Different ledger accountsDifferent journal entries for purchase, purchase returns and sale of inventoryDifferent amounts for cost of sales and inventory on balance date13JOURNAL ENTRIES -PerpetualAccounting for Purchase TransactionsPurchased merchandise worth $1400 from Jet Li Pty Ltd, a supplier on creditDateAccountTermsPostPurchasesGST OutlaysAccounts PayableJet Li P/L1,4001401,540

Purchases Journal excerptUnder the perpetual system every Purchase requires a posting to the subsidiary ledger AND the Inventory ledgerItem M-200PurchaseSellBalanceDatePostQtyPriceTotalQtyPriceTotalQtyPricetotalPJ100141400100141,400Jet Li Pty LtdDateDetailsPostDebitCreditBalancePJ1,5401,540

JOURNAL ENTRIES -PerpetualAccounting for Sales TransactionsSold 80 items of merchandise for $1,600 plus GST to Ray Stevens, a customer on creditDateAccountTermsPostSalesGST CollectAccounts ReceivableRay Stevens1,6001601,760Sales Journal excerptDateAccountPostDebitCreditCOGS1,120 Inventory (80 items @ $14)1,120 Sold inventoryUnder the perpetual system every sale requires an entry into the GJ and posting to the subsidiary and inventory ledgers (next slide)Note these two accountsJOURNAL ENTRIES -PerpetualAccounting for Sales transactions- post to 2 ledgersSold 80 items for $1,600 plus GST to Ray Stevens on creditItem M-200PurchaseSellBalanceDatePostQtyPriceTotalQtyPriceTotalQtyPricetotalPJ100141,400100141,400GJ(6)14(84)94141,316SJ801411201414196Ray Stevens subsidiary ledgerDateDetailsPostDebitCreditBalanceSJ1,7601,760

And now post to the subsidiary Inventory ledgerNo running record of each purchase and saleAdditional inventory purchased is recorded in the Purchases account, instead of the Inventory accountThe balance in the inventory account therefore does not change until the end of the accounting periodA stocktake is performed to determine the closing inventory balanceThis closing balance is then used to determine the Cost of SalesSUMMARY - PERIODICJOURNAL ENTRIES -PeriodicAccounting for Purchase TransactionsPurchased merchandise worth $1400 from Jet Li Pty Ltd, a supplier on creditDateAccountTermsPostPurchasesGST OutlaysAccounts PayableJet Li P/L1,4001401,540

Purchases Journal excerptUnder the periodic system every Purchase requires a posting to the subsidiary ledger no other GJ entry is requiredJet Li Pty Ltd subsidiary ledgerDateDetailsPostDebitCreditBalancePJ1,5401,540

JOURNAL ENTRIES -PeriodicAccounting for Sales TransactionsSold 80 items of merchandise for $1,600 plus GST to Ray Stevens, a customer on creditDateAccountTermsPostSalesGST CollectAccounts ReceivableRay Stevens1,6001601,760Sales Journal excerptRay Stevens subsidiary ledgerPostDebitCreditBalancePJ1,7601,760Under the periodic system every sale requires no additional GJ entry needed, only posting to the subsidiary ledgerCONTRASTING THE TWO METHODSNote that the COS account balance is already recorded under the Perpetual systemUnder the Periodic system, COS needs to be calculated.Perpetual = more work and more detail/controlPeriodic = less work, less detail/controlWhich method?Cost/BenefitJOURNAL ENTRIEScash discounts21CRJDebitCreditDateAccountPostBankDisc allGST CollSalesAcc RecOtherGST CollR Stevens140126.402.601430CPJDebitCreditDateAccountChq NoPostPurchAcc PayOtherGST OutBankDisc RecGST OutJet Li Pty Ltd1447.601418.626.402.60To receive and pay accounts within the discount period

Cash Receipts JournalCash Payments Journal21COGS & Ending InventoryAll firms no matter which system they use (perpetual or periodic) need to know two amountsThe Cost Price of all inventory sold during the period -COGSThe amount shown for ending inventory (inventory left on the shelves) on balance date22Is this a problem?For a perpetual system they will keep a running balance of ins and outs (purchases and sales of inventory) and will have up to date informationFor a periodic system they dont keep running balances and so need to find the amount of ending inventory by doing a stock take and working backwards2324Assigning Cost to Ending Inventory & COGSCost of all inventories must be assigned using* either thefirst-in, first-out (FIFO) method orweighted average cost methodSpecific identification

Firms must also:Disclose which inventory costing method they are usingBe consistent to ensure inventory information is comparableBe conservative following the LCM, or lower of cost or net realisable value rule * Note: use of the last-in, last-out (LIFO) method is not permitted in Australia25Determining the cost of inventory sold Cost =cost of purchase+cost of conversion (if manufacturing)+other costs to bring inventoryto present location & conditionCost is easily determined if the price does not change

Butif prices change over time, which price do we use to cost our ending inventory?EXAMPLE INVENTORY COSTINGPERIODIC SYSTEMDateNumber of UnitsUnit CostTotal Costs1 JulyBeginning Inventory10$10$100.00Purchases made during the current period15 Sept.Purchases1211132.007 Dec.Purchases1512180.00Total purchases27312.00Goods available for sale37$412.00Sales made during the current period20 Sept.Sales8??12 Jan.Sales10??Total cost of sales18?30 JuneEnding Inventory19?2627Limitations of the periodic methodSo what are the limitations of the periodic method?

The balance of inventory is not readily availableIf you want to know stock on hand you must count it

The COGS is not readily availableIf you want to know COGS you must calculate it by: COGS = opening inventory + purchases closing inventory

COGS = BI + NP EI

We never really know how much we have soldWe assume that if it is not there, then we have sold it but the inventory may have been sold, or it may have been stolen, lost, broken, evaporated etc 28First-in, First outUnits cannot be specifically identified. This is a concept- not the actual movement of inventory. FIFO assumes that the earliest purchases of inventory will be the first units to be sold.The units that remain in inventory are assumed to be the ones that were from the latest purchases. (ie newest) (therefore ending inventory reflects current prices)So looking at our previous slide- using FIFO the ending inventory is 100+88=$188 and the COGS is = $412-188=$224

29Using the data in Exercise 13.2 page 585What is the cost of sales and ending inventory using FIFO and a periodic system (not perpetual)?How many units in opening?How many units purchased?How many units available for sale?How many units sold?How many units left on the shelf?What is the value for COGS and ending inventory?COMPARISON OF COSTING METHODSSpecific IDConsistent with the actual movement of the inventoryOffers room for manipulating profitFIFOReflects current prices in ending inventoryDoes not permit manipulation of profitWeighted average Results in identical items being assigned the same valueTends to smooth out profit and inventory values

30THE LOWER OF COST AND NET REALISABLE VALUE RULEAccounting standards require inventories to be valued at the lower of cost and net realisable valueNet realisable value is the estimated selling price in the normal course of business less the estimated costs of sale.

31GST remitted to ATODuring the year, the company collects GST from customers and pays GST to suppliers. The GST the company pays is called an input tax credit and the ATO credits the company with this amount. As the ATO also wants its amount collected from customers, the company deducts their credits and remits the balance to the ATO. This will be the difference between outlays and collections.

July 28GST Collections130 000GST Outlays110 000Cash at Bank 20 000to record the June quarter paymentof GST to the ATOGST ProblemOn 30 June 2010 the ledger accounts of T Ltd show the following balances. These balances are reflected on the BAS for the June quarter.GST collections: $2 500 crGST outlays: 3 000 drRequired: Complete the journal entry requiredto reflect the clearing of these accounts on the submission of the BAS.33